wp_list_categories output

I’m hoping someone can please shed some light on this for me. I’ve been up and down the forums but can’t find anything that really explains this.

Why does:
<?php wp_list_categories('title_li=<h2>' . __('Categories') . '</h2>&echo=0' ) ?>

output:

<li class="categories">
<h2>Categories</h2>
<ul>
<li>Item 1</li>
<li>Item 2</li>
</ul></li>

Instead of:

<h2>Categories</h2>
<ul>
<li>Item 1</li>
<li>Item 2</li>
</ul>

?
And a better question, how does one get it to behave properly? I’d imagine something like this would be what I’m looking for, but I don’t know how to tweak it to call categories instead of pages.

Thanks for any input.